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Cash-out refinancing is when you take out a new mortgage with a larger principal than your current mortgage. The purpose is not to necessarily get a lower interest rate on your mortgage, but to turn your home equity into cash that you can use.
Explanation
When you use cash-out refinancing, the difference in what you owe on your house and what it’s worth (the equity) is paid to you as cash. The cash can then be used for almost any purpose, including debt consolidation.
Because of how cash-out refinancing works, you are only eligible for it if you have equity in your home. Home equity is the part of the home that you actually own. For example, if your home is worth $150,000, and you owe $100,000 on the mortgage, you have $50,000 equity. That $50,000 is available for you to use, depending on your lender’s rules.
Debt consolidation
Suppose you have $50,000 in credit card debt and you are paying an 18 percent interest rate. You can get a much lower interest rate by using your home equity. At closing, you get that $50,000 in cash and can use it to pay off your credit card debt. Once you do that, the debt is wrapped up into your mortgage. This can be advantageous when used wisely. Instead of paying an 18 percent interest rate that is not tax deductible, you pay a much lower rate, usually around 6 percent, and get tax benefits since the debt is tied to your mortgage.
Does cash-out refinancing make sense for you?
There are situations in which it makes sense to use cash-out refinancing to consolidate debt. When trying to determine if it’s a good option for you, consider the following questions.
If you answered yes to all or even most of these questions, then cash-out refinancing may be a smart thing for you to use to pay off your debt.
Keep in mind, though, that cash-out refinancing is not always the best choice. It can be a foolish move if you do not stop overspending. If you use cash-out refinancing and then rack up more debt, you just wind up with larger debt on your mortgage plus even more credit card debt. If you choose cash-out refinancing as an option, be sure to use financial restraint. Do not forget that the debt will now be tied to your mortgage, making it possible for you to lose your home if you do not make your payments on time.
If you need to stop paying high interest rates on debt and can avoid running up more debt, cash-out refinancing is an option to consider.
Published on June 15, 2006